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The coming revolt of financial savings

Feb 11, 2013

In a column on January 14, 2013, a plea was made that against the backdrop of the high inflation rate, the large fiscal deficit, the large balance of payments current account deficit (CAD), the over-valued rupee exchange rate, the overextension of credit by banks and sluggish deposit growth, there was no case for easing monetary policy.

The decision of the Reserve Bank of India (RBI) on January 29, 2013, was to ease monetary policy. Taking comfort from the fact that the RBI and the government are on the same page implies that the RBI has been browbeaten into submission. Witness the convoluted rationale that an easing of monetary policy would facilitate growth, reduce inflation, reduce the large CAD and the fiscal deficit. The world over, the present time is adverse for central banks, as governments think it their divine right to direct central banks.

Commercial Banks' Response

The banks' initial response to the reduction of the repo policy rate and the cash reserve ratio by 0.25 percentage points each was to please the masters by reducing lending rates. The articulate Ms. Chanda Kochhar, CEO and MD of ICICI Bank, in a rather intriguing statement, has said: "It is not right to assume that if lending rates will go down, deposit rates will also go down." The lowering of the CRR and the reduction of the repo rate, by themselves, would only enable a very small reduction in lending rates. Invariably banks reduce deposit rates faster than lending rates. A meaningful reduction in lending rates is not possible unless deposit rates are lowered. Thus, depositors should not be lulled into confidence that deposit rates would not fall.

Reduction of the Savings Bank Deposit Rate?

There are rumblings that in the Monetary Policy for 2013-14 (on May 3, 2013) banks would be required to pay savings bank depositors monthly interest. Although savings bank deposit rates have been deregulated, public sector banks, large private sector and foreign banks are paying 4 per cent on these deposits (i.e. the erstwhile controlled rate). If an individual bank reduces its savings bank rate, there is a strong possibility of the bank experiencing an exodus of savings bank deposits. If banks, as a monolith, undertake a co-ordinated reduction of the savings bank deposit rate, they could well face problems of cartelisation.

What should be the strategy of depositors? To the extent possible, depositors should consider moving to banks that offer up to 7 per cent on savings bank accounts. Again, depositors should keep savings bank deposits to the minimum level possible and shift to fixed deposits, which offer substantially higher rates without penalties for early withdrawal.

Abolition of the Fixed Deposit Premium for Senior Citizens

The financial services department of the ministry of finance, asserting its proprietary rights, has directed public sector banks to abolish the senior citizens' premium on fixed deposits, which ranges between 0.50-0.75 per cent. This premium was consciously introduced over a decade ago on social considerations as also because these deposits are stable. This is an insensitive move by the government. It reflects a policy of inflicting punishment on the vulnerable segments of the population. It is hoped that the government's top policy honchos recognise the insensate nature of this measure and they should categorically foreclose the bureaucracy from undertaking this measure.

Inflation Indexed Bonds

With a view to weaning away savers from gold, the government is giving serious attention to introducing five year Inflation Indexed Bonds IIBs). To be effective in reducing the demand for gold, the IIBs should carry a real rate of interest, say 3 per cent, plus an inflation compensation equal to the Consumer Price Index (CPI) increase during a year.

If, over a period of five years, the cumulative inflation is 40 per cent, on a face value of a bond of Rs 100, on redemption the holder should get Rs 140.

Furthermore, if in a year, the CPI shows an increase of say 10 per cent, the bond holder should be paid a nominal rate of interest of 13 per cent. If, in a subsequent year, the increase in the CPI is only 4 per cent, the bond holder should be paid a nominal interest rate of only 7 per cent. It could be argued that the bond would be costly to the government if inflation is not controlled. Such a bond would provide a strong incentive to government to run monetary-fiscal policies in a manner that there would be a sharp reduction in inflation. It is often not recognised that a low inflation rate would be of major benefit to the government as large payouts by way of dearness allowance, subsidies and other payments would be lower. If the government wishes to introduce IIBs without attractive features, curbing of gold imports would just not be possible.

Revolt Against Financial Savings

The government should take serious note of the decline in household savings in financial assets from 12.9 per cent in 2009-10 to 10.0 per cent in 2010-11 and further to 7.8 per cent in 2011-12 (RBI Annual Report for 2011-12). This should be a strong signal to the government to reverse its wonton policy of hurting financial savings. If the government persists in pursuing this disastrous path, there will be a faster decline in household sector savings in financial assets and a move to gold and other financial assets. Investors in financial assets can no longer be injured with impunity and a backlash is inevitable. If the government persists in its policy of reducing incentives for financial savings, a major savers' revolt could well be on the cards. Savers would move from financial assets to physical assets. The policy on financial savings is at a crossroads and one fervently hopes that the government sends a strong signal in the union budget on February 28, 2013, to encourage financial savings.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

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